Conflicted Merger Transactions: Consolidating the Standards of Review

Conflicted Merger Transactions: Consolidating the Standards of Review

Article excerpt

INTRODUCTION

This Note addresses the varying standards of review for mergers, which exist due to the myriad methods of negotiating such transactions. While the landmark cases Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985) and Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) addressed the standards of review applicable in instances where the board of directors faced the threat of a hostile takeover, they did not address the level of scrutiny placed on a board in other instances.

Several cases since then have narrowly addressed the issue, but each case is an isolated example of the level of care a board of directors must assert in a particular transaction. In Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110 (Del. 1994), the court required a review under the entire fairness standard. The Delaware Chancery Court in In re Pure Resources, Inc., Shareholders Litigation, 808 A.2d 421 (Del. Ch. 2002) further parsed the different standards of review based on whether the merger was a result of a negotiation or a tender offer.

However, there still exists a lack of clarity as to whether the standard of review for a conflicted merger should be the entire fairness standard, the business judgment rule, or enhanced scrutiny. Configuring the standards of review based on the structural elements of the transaction has resulted in varying interpretations of the same basic principle.

Finally, although a variety of literature exists on the roles of these cases in elucidating the standards of review for mergers, this Note will seek to consolidate the new standards set out by courts in recent years, and highlight the areas where clarity is still required. The Note will also propose a solution for addressing the potential conflict posed by the differing standards of review, and address any gaps in the law. The Note will serve as a useful outline of the information available to the board of directors of a corporation for assessing the scrutiny it might face if its decisions during a merger (or a similar transaction) are under review.

Accordingly, Part I provides an overview of the existing standards of review for mergers, and their underlying principles; Part II discusses the conflicting case law, and highlights areas where there is a lack of clarity; Part III proposes a solution and calls for a consolidation of the standards of review for mergers involving a conflict of interest.

I. MERGERS

Companies merge for a variety of reasons: when they expect increased profits, anticipate a better competitive position, or simply wish to diversify the products and services they offer. Regardless, the manner in which these merger transactions are negotiated and ultimately structured has a huge impact on any judicial review that the transaction might face. As this Note shows, the different transactions are analyzed under differing levels of scrutiny, depending on the level of perceived conflict between the interests of the shareholders and those of the board of directors.

A. FORMS OF MERGER TRANSACTIONS

Although mergers can be structured in a variety of ways, the two most relevant to this discussion are mergers accomplished by combining two companies with diversified shareholders, and those configured as freeze-out transactions.1

I. The A-B Merger: Combination of Two Companies with Diversified Shareholders

This involves a negotiated merger between two companies A and B whose shareholders are dispersed. The transaction can be accomplished in two ways.

a. Cash-based Transaction

Company B's shareholders are bought out and only A's shareholders hold the resulting company AB's stock. B's shareholders are no longer invested in company B or AB.

b. Stock-based Transaction

Company A's stock is given to B's shareholders. Here, both A's and B's shareholders remain shareholders in the resulting company AB.

2. The A-C Merger: Freeze-out Transactions

This involves a merger transaction between company A and another company C, which is controlled by A. …